How to Strategically Manage Your Debt

By Jocelyn Black Hodes, DailyWorth's Resident Financial Advisor

September 23, 2013

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Take Control

Debt. Funny how four little letters can feel so dirty. Most of us have it in one shape or another, but none of us like to talk about it. Debt can get us into trouble, especially if it is unplanned and uncontrolled. And some of us can’t help but feel out of control when it comes to our debt. Whether the debt is big or small, owing money can be uncomfortable and stressful, regardless of your financial status. What we often forget is that debt can also be a tool commonly used to get ahead, whether it is borrowing for education, for business or for a home that we assume will appreciate over time.

Of course, debt can be extremely dangerous and detrimental to your financial success if you aren’t careful and diligent about managing it. But if you are, debt doesn’t have to be all bad; in fact, it can even help you reap some serious rewards.

There are strategic ways to approach debt so that it works to your advantage, as long as you are disciplined enough to follow the rules. To help you control and leverage your debt -- and not the other way around -- we have highlighted the main categories of debt and some of the key dos and don’ts of using it.

Credit Card Debt

The average household with credit card debt owes just over $15,000. And according to the FINRA Investor Education Foundation, 60 percent of women carry a credit card balance. It is easy to let credit card debt get out of hand if we aren’t mindful about it. But with some simple strategies, you can gain, rather than lose, from your credit card debt. Here’s what you need to do:

Shop around. Plenty of sites (try creditcards.com or nerdwallet.com) are trying to make money by referring you to creditors and keep you coming back with a variety of resources and information. They also help you narrow down choices based on a variety of criteria you can customize.

Negotiate with creditors. Yes, it takes a time commitment and potential frustration dealing with multiple representatives, but the benefits (including better rewards, lower rates, waived fees and higher credit limits) can be worth it.

Leverage the payment cycle. If you charge something the day before your statement closes, you get an interest-free period of 20 to 25 days to pay it off. But if you wait until the day after your statement closes, then you can get an extended interest-free period of up to 55 days.

Take advantage of store card offers. Big retailers often offer big discounts on purchases if you open a credit account with them and continue to use their card in the future. This can mean serious savings, as long as you pay off the balance in full on time, every time. However, there are more flexible store cards offered by banks that can allow you to get discounts at a variety of retailers instead of just one. Compare current offers here.

Use your cards regularly. Doing so -- and making payments on time, of course -- will boost your credit score and encourage your creditors to automatically increase your credit limit, helping even more. It will also help you rack up rewards faster.

Reap your rewards. Too many people neglect to actually cash in on their available rewards (which can include travel discounts, cash back, concierge services and more). Check your card’s website for details on their particular program and make sure you don’t miss out.

Consider a balance transfer. If you are currently nearing the end of a promotional rate period and won’t be able to pay off your total balance in time, or if you are already paying high interest on an existing balance, consider transferring it to another card in exchange for a lower rate. This can buy you extra time to pay off your balance and save you a lot in interest payments. Watch out for balance transfer fees, though, and do the math first.

On the other hand, it is important that you never miss a credit card payment and try not to use up too much of your available credit. Missed payments are the biggest threat to your credit score, followed by a high credit-utilization ratio (under 30 percent is ideal). To help avoid potential trouble, use this tool to stay organized and create a clear debt payoff plan, if need be.

Student Loan Debt

Today, two-thirds of American students graduate with student loan debt, and the average grad leaves school with more than $26,000 of debt, according to the Institute for College Access & Success. Student loan debt can seem overwhelming, especially when the average post-grad job in 2013 only pays around $45,000 a year. However, with its relatively low interest rates and tax-deductible interest, student loan debt is generally considered to be a “good debt.” Here’s what you need to know to manage it strategically:

Map out career and income goals along with a loan repayment schedule early. Think of it like a business plan with a break-even projection and future profit estimates. This will help you budget accordingly and stay motivated to make that borrowed education pay off sooner than later.

Pay private loans first and federal loans second, in order of interest rate (high to low).

Understand your repayment options. You may be able to pay a lesser amount based on your current income or even have your debt forgiven in some cases. Explore your options here.

Teach or serve your community to save. If you are willing to be strategic about your career path, you can have as much as $17,500 of your loans forgiven through the Teacher Loan Forgiveness program or have the balance of your debt forgiven after 120 payments through the Public Service Loan Forgiveness program.

Remember your tax deduction. You can deduct up to $2,500 (in 2013) or the total amount you paid in student loan interest (whichever is less, as long as your income is below the IRS limits), saving you money on your tax bill.

If you’re looking to simplify and potentially lower your payments, consider consolidating. Be careful, though. If you aren’t going through the government’s loan servicer, you will likely get stuck paying fees that cost you more in the long run. You also might lose certain benefits offered by your original lender. Before deciding, review this consolidation checklist.

Just like with your credit card, missing a student loan payment can result in fees and penalties that make it harder for you to qualify for other loans, like a mortgage. And if you can afford it, don’t defer your payments. It’ll cost you more in accrued interest, and it’ll take you longer to get out of debt. If you’re having trouble making payments, call your lender and explain your situation. They are much more likely to help you if you are proactive and honest.

Mortgage Debt

The average household today owes over $147,000 in mortgage debt, according to the Federal Reserve. And while some argue that the traditional American dream of owning a home is more of an unrealistic fantasy these days, for those who can afford it, homeownership is still one of the best long-term investments, especially with interest rates at historic lows (approximately 3.5 percent for a 15 year and 4.5 percent for a 30 year).

Go with a 15-year fixed mortgage if possible. It will cost you more per month than a 30-year, interest-only or adjustable loan, but you will pay off the debt much sooner and save big money in the long run that you can invest toward other goals.

Consider an adjustable-rate mortgage (ARM) with a low initial interest rate and monthly payment if you are sure you will only be in your home for less than five years. You can save significant money that can (and should) go towards other goals. If there is a chance you might stay in your home longer, an ARM can be too risky. Check out this calculator to help decide if an ARM makes sense for you.

Take advantage of tax deductions. Interest paid on mortgage debt on your primary or second home is tax deductible. Points are also deductible. Check with a tax expert for personalized guidance and to maximize your savings.

Do the math to see if refinancing makes sense. You might be able to lower your interest rate and monthly payment, but it also means extending the length of your loan and paying thousands of dollars in closing costs in many cases. However, if you plan to stay in your home longer than it takes to break even on a refinance, it can be worth it.

Remember that multiple types of credit inquiries can raise a red flag to lenders, so don’t apply for other loans when you’re home shopping. Once you find the home you love, put at least 20 percent down. Otherwise, you have to pay private mortgage insurance (PMI). If you can’t afford to put down 20 percent, you can’t afford that home and should steer clear of it.

HELOC Debt

A home equity line of credit (HELOC) is an option for homeowners willing to use their home’s equity as collateral in exchange for liquidity. Because homes are typically a person’s greatest asset, only use a HELOC to pay for capital investments that add value, such as home improvements, financing other real estate investments, education or business financing. Here’s how to get the most out of your HELOC:

Shop around. A good place to start is with your current lender, but you might be able to research a better deal.

Read all the fine print on loan fees, interest rate, repayment terms and any potential limitations and risks. Most HELOCs come with a variable interest rate, so you need to be prepared for fluctuating monthly payments. Some lenders offer a low, fixed promotional interest rate for a period of time (that eventually adjusts to a higher, variable rate) or a fixed rate in exchange for a higher monthly payment.

Know that you have the right to cancel. Federal law gives you three days to reconsider a signed credit agreement and cancel the deal without penalty. You can cancel for any reason, but only for loans on your primary home, not a vacation or second home.

Avoid using a HELOC for emergencies if possible (unless a high-interest credit card is your only other option) and don’t use a HELOC to consolidate debt if you aren’t prepared to stop living beyond your means. In some cases, a HELOC can easily enable more overspending leading to serious trouble, including bankruptcy. Don’t give in to the temptation to use a HELOC to buy things that will likely depreciate in value (cars, vacations, clothes or furniture). And don’t forget to deduct your HELOC interest up to $100,000 come tax time.

Car Loan Debt

If you’re someone who is tempted to buy cars and wants to maximize your savings in the short term (and ideally invest the difference!), leasing a car is the way to go. But if you’re committed to driving the same car for five or more years, buying may be for you. Here’s what you need to know before taking out a car loan:

Be armed when going to the dealer. Dealers are eager to make extra money by getting you into a loan through their own lenders and pushing a higher rate on you based on their determination of your credit score. Know your credit score from each of the three credit bureaus and research third-party loan options ahead of time. You can get a free, comprehensive report each year at annualcreditreport.com. Print out your credit report and a few offers to bring with you to the dealer to help negotiate and save money.

Be wary of add-ons. Remember, dealers make the majority of their money by selling credit insurance, extended warranties and other “extras” that aren’t really necessary.

Pay more each month if possible. If you don’t have other, higher-interest debt weighing you down and you have a comfortable emergency fund, you should set up automatic, bi-weekly loan payments. Specify that the extra money should be applied to your loan principal rather than future interest.

Consider gap insurance. From the moment you drive a car off the lot, your car insurance is likely inadequate in the event you suffered a total loss from an accident or theft. If you paid cash for your car or have significant equity in it, you don’t need gap insurance, but in many cases, it can be a smart investment for financial protection. Shop for quotes and get more info here.

Though it may be tempting, don’t finance a new car, as depreciation is the greatest in the first few years of a car’s life. And before you take out a car loan, make sure your total debt (from mortgage and credit cards, etc.) doesn’t exceed 36 percent of your gross annual income.

In most cases, refinancing a car loan isn’t a smart bet. Excessive fees typically cancel out any short-term savings. The rare exception to this rule is if you happen to have the means to pay more per month in exchange for a shorter loan term, which can save you significant interest. Use this calculator to help you decide.

Investment Debt

Just as banks can lend you money if you have equity in your home, your brokerage firm can lend you money against the value of certain stocks, bonds and mutual funds in your portfolio. This is known as a margin loan. Here’s what you need to do before taking on investment debt:

Understand the risks. Borrowing on margin is not for the amateur investor. Margin can result in losing more than your original investment. However, you could also boost your return significantly.

Only consider margin if your marginable portfolio is diversified enough and large enough (relative to the level of margin debt) to help reduce risk. In this case, margin can be a convenient, flexible and low-cost borrowing tool to leverage your investments.

Opt for margin over other debt if you can. Margin interest rates are typically lower than credit cards and unsecured personal loans, plus there’s no set repayment schedule with a margin loan. Margin interest may be tax deductible if you use the margin to purchase taxable investments. Consult a tax professional about your individual situation.

Don’t borrow the max. Investors can generally borrow up to 50 percent of the purchase price of marginable investments, but pushing the limits can be extremely risky. A decline in the value of securities purchased on margin can require you to provide additional funds to the lending brokerage firm within a short time to avoid the forced sale of those securities or other securities in your account. And remember to double-check your firm’s margin policies, as they can differ between firms.

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